Supervision and Regulation Letters

SR 11-15:

BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM
WASHINGTON, D.C. 20551

DIVISION OF BANKING
SUPERVISION AND REGULATION

SR 11-15December 21, 2011

TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK

SUBJECT:

Disposal of Problem Assets through Exchanges

Applicability to Community Banking Organizations: This letter applies to all state member banks, bank holding companies and their nonbank subsidiaries, and savings and loan holding companies that engage in asset exchange transactions, including those with $10 billion or less in consolidated assets.

Financial institutions are increasingly exploring strategies to dispose of or reduce nonperforming assets and other real estate owned (OREO). Some of these strategies include so-called "asset exchanges," whereby third parties or marketing agents have offered to purchase problem assets from institutions and replace them with performing assets. While such transactions, if properly executed with reputable counterparties and subjected to the appropriate level of due diligence, could achieve the objective of reducing nonperforming assets on financial institutions' balance sheets, Federal Reserve staff have been made aware of transactions that may present significant risk to institutions and could compromise their safety and soundness. To date, these transactions have been encountered primarily at smaller community banks.

The Federal Reserve is issuing the attached guidance, including an example of an asset exchange transaction, to highlight the potential risks associated specifically with transactions which may reduce problem assets in the short term, but where a lack of appropriate, up-front due diligence may result in heightened risks over the longer term. In addition, inappropriate assumptions used in determining the fair value of the purchased assets may result in institutions being required to recognize losses shortly after inception of the transaction.